Why you should always be sceptical of new funds promising miracle returns
Many market-beating strategies could be an illusion caused by the constant search for new ways to sell funds, says Cris Sholto Heaton.


There’s a well-known problem in many fields of research where findings from one group of researchers can’t be confirmed by others who try to repeat the same experiment. Areas such as psychology, sociology and medicine are especially prone to this – one study found that only half of a set of psychology experiments could be reproduced, with a number of high-profile and influential findings turning out to be false.
This isn’t necessarily because of fraud on the part of the original researchers; patterns will often emerge by pure chance if you crunch a set of data for long enough, and the incentive for researchers to keep crunching until this happens means that they can end up with a finding that appear to be statistically significant but is really just noise.
In theory, investing should have less of a problem than most fields. Ideas for strategies to deliver better performance will always be tested in the real world. If too many are failing, it should be obvious. Yet that assumption may be too optimistic, according to Campbell Harvey, professor of finance at Duke University in the US. In an interview with the Financial Times, he suggests that at least half of 400 market-beating strategies published in reputable financial journals can’t be replicated.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Results in the real world
Some researchers come to the same conclusion – a paper by Kewei Hou, Chen Xue and Lu Zhang (Replicating Anomalies) found that more than 80% of results they studied could not be reproduced. Others dispute it: Is There a Replication Crisis in Finance? by Theis Ingerslev Jensen, Bryan Kelly and Lasse Heje Pedersen reckons most findings they review appear to hold up. The debate remains live on an academic level, but there is some practical evidence to support it.
You’ve probably seen asset managers proudly launch new funds that have a great record in backtesting, but fail to deliver in the real world (this is true of many smart beta ETFs – see below). The chart above – from Research Affiliates and reproduced in a recent paper by Harvey – shows the average performance of the indices used for new US ETFs. On average, indexes strongly outperformed the market in the 36 months before ETF launches – but that outperformance tended to disappear over the next three years.
In some cases, the successful strategy will have been a statistical illusion from cherry picking or twisting data. Sometimes real-world transaction costs eat away at theoretical excess returns. Or the wider market environment may change (value strategies had a long record of success but have done badly for the past decade). Regardless of the reasons, investors should always be sceptical of new products promising miracle returns.
I wish I knew what smart beta was, but I’m too embarrassed to ask
Finance theory divides investment returns into two parts. Alpha is the value added through the decisions made by you (or the manager of the fund you hold). Beta is the return that results from the overall market.
Assume that a portfolio of investments goes up by 15% while the overall market rises 10%. In this case, beta is 10% and alpha is 5% (15%–10%). In reality, the calculation is a bit more complicated because it depends on whether the type of stocks in the portfolio would be expected to fluctuate more than the overall market, but this demonstrates the idea. Beta is what you get from simply being invested in the market (ie, what a passive index investor gets); alpha is what an investor gains or loses from active investment management.
Smart beta strategies lie between active and passive investing. A smart beta fund tracks an index, but with that index constructed differently to a traditional stockmarket index. Instead of weighting securities by size, a smart beta index selects or weights according to characteristics that may make them more likely to outperform the wider market. Common characteristics (often called factors) include variations on size (historically, small stocks tend to outperform larger ones on average); value (stocks that seemed cheap on metrics such as price/earnings or price/book have tended to outperform expensive ones); volatility (less volatile stocks have tended to do better); momentum (stocks that are rising strongly may be more likely to keep rising); and quality (profitable, efficient business with less debt have tended to beat weaker ones).
Advocates of smart beta say that it can deliver higher returns than passive investing in a cheaper and more systematic way than active investing. This makes sense in principle, but depends on the continued success of the factors chosen for the smart beta strategy. There can be no certainty that a factor that worked in the past will keep doing so.
Sign up for MoneyWeek's newsletters
Get the latest financial news, insights and expert analysis from our award-winning MoneyWeek team, to help you understand what really matters when it comes to your finances.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
-
8 of the best houses for sale with home cinemas
Houses for sale with home cinemas – from a modern oast-house style property in Kent to a house in Buckinghamshire with Dolby sound and bespoke seating
By Natasha Langan Published
-
Rachel Reeves faces £23 billion capital gains tax “black hole” – will she be forced to look elsewhere?
The fiscal watchdog has downgraded its forecast for capital gains tax revenues, leaving chancellor Rachel Reeves with £23 billion less than previously expected
By Katie Williams Published
-
Large cap stocks start to struggle – is it time for investors to reassess their focus?
Buying quality large caps worked very well last decade. A more volatile world will be a bigger challenge for these star stocks, says Cris Sholto Heaton
By Cris Sholto Heaton Published
-
How to generate income with fixed-interest investments
Public debt is overvalued, but other fixed-interest investments now look like a bargain, says Max King
By Max King Published
-
Three top-notch Taiwanese companies cashing in on the advent of AI
Opinion Eric Chan, investment director and co-manager of the Aberdeen Asian Income Fund, highlights three potential Taiwanese winners in the technology industry
By Eric Chan Published
-
Weight-loss drugs could revolutionise the economy – the investments to buy now
The new generation of weight-loss drugs are a boon for the overweight, but they also promise to change our relationship with food and revolutionise the economy
By Dr Matthew Partridge Published
-
Find tomorrow’s Asian giants while they are still smaller companies
Opinion Nitin Bajaj, portfolio manager of the Fidelity Asian Values trust, picks three Asian companies to invest in.
By Nitin Bajaj Published
-
AI will maintain Moody’s market lead, says Stephen Connolly
Opinion Veteran data provider Moody's has adapted well to the modern world, and is one of Warren Buffett’s longest-held investments
By Stephen Connolly Published
-
Is BlackRock World Mining gearing for a recovery?
Opinion After a frustrating year, BlackRock World Mining is positioned for growth and to capitalise on the sector's recovery
By Rupert Hargreaves Published
-
Should you limit exposure to US tech stocks?
An end to the AI boom would shake both US funds and global trackers. Here’s one way to trim exposure to US tech stocks
By Cris Sholto Heaton Published